portfolio mgmt models

7/29/2019 Portfolio Mgmt MOdels

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ortfolio management refers to the art of managing various financial products and

assets to help an individual earn maximum revenues with minimum risks involvedin the long run. Portfolio management helps an individual to decide where and how

to invest his hard earned money for guaranteed returns in the future.

Portfolio Management Models

1. Capital Asset Pricing Model

Capital Asset Pricing Model also abbreviated as CAPM was proposed by

Jack Treynor, William Sharpe, John Lintner and Jan Mossin.

When an asset needs to be added to an already well diversified portfolio,

Capital Asset Pricing Model is used to calculate the assets rate of profit or

rate of return (ROI).

In Capital Asset Pricing Model, the asset responds only to:

Market risks or non diversifiable risks often represented by beta

Expected return of the market

Expected rate of return of an asset with no risks involved

What are Non Diversifiable Risks ?

Risks which are similar to the entire range of assets and liabilities are called nondiversifiable risks.

Where is Capital Asset Pricing Model Used ?

Capital Asset Pricing Model is used to determine the price of an individual

security through security market line (SML) and how it is related to systematic

risks.

What is Security Market Line ?

Security Market Line is nothing but the graphical representation of capital asset

pricing model to determine the rate of return of an asset sensitive to non

diversifiable risk (Beta).

2. Arbitrage Pricing Theory

Stephen Ross proposed the Arbitrage Pricing Theory in 1976.


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Arbitrage Pricing Theory highlights the relationship between an asset and several

similar market risk factors.

According to Arbitrage Pricing Theory, the value of an asset is dependent onmacro and company specific factors.

3. Modern Portfolio Theory

Modern Portfolio Theory was introduced by Harry Markowitz.

According to Modern Portfolio Theory, while designing a portfolio, the ratio of

each asset must be chosen and combined carefully in a portfolio for maximumreturns and minimum risks.

In Modern Portfolio Theory emphasis is not laid on a single asset in a portfolio,

but how each asset changes in relation to the other asset in the portfolio with

reference to fluctuations in the price.

Modern Portfolio theory proposes that a portfolio manager must carefully choosevarious assets while designing a portfolio for maximum guaranteed returns in the

future.

4. Value at Risk Model

Value at Risk Model was proposed to calculate the risk involved in financialmarket. Financial markets are characterized by risks and uncertainty over the

returns earned in future on various investment products. Market conditions can

fluctuate anytime giving rise to major crisis.

The potential risk involved and the potential loss in value of a portfolio over acertain period of time is defined as value at risk model.

Value at Risk model is used by financial experts to estimate the risk involved in

any financial portfolio over a given period of time.

5. Jensens Performance Index

Jensens Performance Index was proposed by Michael Jensen in 1968.

Jensens Performance Index is used to calculate the abnormal return of any

financial asset (bonds, shares, securities) as compared to its expected return in any

portfolio.

Also called Jensens alpha, investors prefer portfolio with abnormal returns orpositive alpha.


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Jensens alpha = Portfolio Return [Risk Free Rate + Portfolio Beta * (Market

Return Risk Free Rate)

6. Treynor Index

Treynor Index model named after Jack.L Treynor is used to calculate the excess

return earned which could otherwise have been earned in a portfolio with

minimum or no risk factors involved.

Where T-Treynor ratio

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